Sunday, June 13, 2010

The Perils Of Having A Little Knowledge

Patrick McGeehan at the New York Times recently wrote about a New York Fed study finding that studying economics makes you a Republican. The headline conclusion is that the more economics classes you take, the more likely you are to be a Republican...

...Studying economics also affects your position on several public policy issues. Of seven issues, economics courses were significantly associated with the five following positions (Table 6):

-Tariffs are bad.

-Trade deficits are not so bad.

-The government should not cap oil prices in response to a supply shock.

-Raising the minimum wage increase unemployment for low-wage workers.

-Income distribution should not be more equal.

These are all pro-free market, anti-government intervention positions.

What I thought was particularly interesting, however, was that on some issues people who study undergraduate economics are more doctrinaire free marketers than professional economists...The Ph.D. economists were more likely than economics majors to hold the textbook position on tariffs or the minimum wage. However, they were also more likely than economics majors (or, frankly, any majors) to think that income inequality should be reduced and that government spending should not be reduced, and they were somewhat less worried about federal budget deficits.

This is something I’ve mentioned in passing often. I think that basic economics, the way it is taught today, tends to give people reflexive pro-free market, anti-government positions — positions that are not held by people with a deeper exposure to economic thinking. When your understanding of government finances is based on reading the newspaper, it’s somewhat eye-opening to come to college and learn that free markets lead to maximum societal welfare and taxes impose a deadweight loss on society — the pictures are so simple and compelling. That’s why a little bit of economics makes you more likely to be a Republican.

But when you learn more about principal-agent problems, information asymmetries, and so on, you learn that those simple pictures are simplistic to the point of being misleading. That’s why Joseph Stiglitz argues in Freefall that understanding economics is crucial to understanding why free markets often lead to suboptimal outcomes. The problem isn’t knowledge per se; it’s a little bit of knowledge.

Notwithstanding my position on subsidies, I’m not in the camp that says that all government intervention is bad, and all policies that create freer markets is good. It depends very much on how intelligently government policy is designed.

There is a good case for saying that, by definition, government policy cannot in fact ever be as truly efficient or effective relative to a free market-based solution. But if market solutions themselves result in suboptimal social welfare outcomes – not unreasonable since few if any real world markets have the necessary characteristics for full efficiency; nor do market solutions always have a moral or social welfare dimension – then government intervention is a valid second-best solution.

Too much of undergraduate economics is based on basic neo-classical/neo-Keynesian theory, which while necessary as a foundation, doesn’t go into the nuances that colour the application of these theories in a real world context. Nor is there any exposure (even at the graduate level) on alternative/heterodox schools of economic thought – you have to discover those on your own.

Spreading knowledge of economics is good, as I’ve always thought of basic economic theory as thought at the undergraduate level as primarily a framework for thinking and discussing policy issues. We’d have a better public discourse on policy and social issues. But as James says, a little knowledge is more dangerous than ignorance – the last thing we need is a revival of the Washington Consensus.

On the other hand, there's a precedent for that as I don't think the situation is any better or worse in other democracies.

But given that, that puts the civil service technocrats on the spot as the main source of policy recommendations and design. It's their job to make sure that policies are designed correctly.

But since we seem to have more than our fair share of cockamamie policies promoted, that means either the inmates are ruling the asylum (i.e. the politicians are actually driving policy design), or the civil service is simply not up to par.

anon, it's not easy to do. The "savings" in the banking system is mixture of both corporate and individual financial assets (a stock measurement) while the savings rate is a "flow" measurement. To use an accounting analogy, one is a balance sheet number, while the other is cash flow. It should theoretically be possible to deconstruct the savings rate from bank "savings" numbers, but it can get complicated, especially since the only account type that is purely from individuals is savings accounts, and you also have to net off net foreign assets. BNM also intervenes in the money market to maintain the target range of the OPR, so it's not a simple matter of just taking the rate of change in bank accounts to arrive at the savings rate.

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About Me

An applied and practicing economist in the Malaysian financial sector.

The purpose of this blog was first to have a way to put down and present my ideas, work in progress, and thoughts on the Malaysian economy. The second reason was to hopefully attract critiques and feedback, that would help me improve on my own understanding of the way the world works, or at least, this little corner of it.